Everyone loves a reversal. Nothing makes a trader feel better than nailing the high or low just as the market turns. Unfortunately it happens once in a blue moon.
So when should you fade the trend?
This is a highly personal subject. So don't take this as gospel, even though it's clearly correct.
Let's use Nucor for an example. One of 34 stocks that screened positively when The Veteran was looking for single names to play catch up in mid-June
Starting with the barest bones of a chart... 👇
In hindsight, it's always so obvious. When you're in the trenches, it's harder. Knowing what you're looking for in advance helps a lot.
As fun as it is to laugh at technical analysis, there's nothing wrong with the techniques of dissecting a chart to make sense of it. It's the belief that lines on a chart are predictive of future behaviour that we can laugh at.
Did your Elliott Waves predict Covid? Ukraine? The Macrodesiac share price rising 50% because I mocked Elliott Wave and a cult of reddit Elliott Wave haters bought in?
Course not. All of this stuff is just frameworks. A way to interpret price behaviours and assess probabilities. None of it should be dogmatically adhered to.
Back to the Nucor chart. Zooming into 2023 with some basic TA.
What's the story? Let's get the crayons out and break it down into phases.
- Nucor clearly peaked in early Feb with that shooting star candle after a sharp (+40%) rally throughout January.
- Price subsequently consolidated during February
- A failed attempt to push on to new highs led to a sharp fall, right back to the range origin of the January rally
- Another month of consolidation concludes with a failed attempt to push higher
- Before a sequence of lower highs and lower lows undoes the entirety of the YTD rally
- And then we try it all again...
Within those six/seven months we see numerous 'reversals'. But how many times could we realistically fade the trend and make money?
There are a few obvious points. The phase 1 rally ends with a beauty of a shooting star (A) AFTER a 40% rally. The signal here is in the context.
If you're looking for a reversal signal, first you need a decent, (ideally parabolic) move to reverse.
Key to note is how the selloff then stalls at the 20 day moving average (B). There's nothing magical about the 20DMA. Just an obvious place to see buyers step in anticipating another leg higher.
After some chop, those buyers are disappointed when the attempted breakout fails (C).
Within all of this, there's only one clear and obvious trade so far. Fading the rally after A, and playing it back to the 20DMA at B.
There are plenty of other trades you could take over a shorter timeframe, but as far as fading the trend goes, there's just that one.
Then we get another big selloff from C.
In real time, I'd say that's relatively tough to anticipate. Bear in mind that it looks like this at the time:
Yes it's a lower high, but still above the 20DMA, consolidating just below YTD highs, why would you confidently short there (based purely on the chart)?
When the parabolic selloff stalls at D, then there's another chance to fade the trend. Right back to the 20DMA again (E).
Then it's chop before the downtrend resumes, ending at F (reversing the entirety of the gains YTD). You can make the case for a reversal from here, and the case is stronger again once the stocks gaps higher, back above the 20DMA once more.
So. In three months, I'd argue that there were three genuine opportunities (A,D,F) to fade the trend. An average of one every two and a bit months.
During that entire period, you can count any number of bullish and bearish engulfing candles, shooting stars, hammers, and whatever else you like.
You can look at the reactions around the 20DMA and pretend there's some signal in there too.
Ultimately though, if you want to fade the trend, you need to find a VERY good reason to do so. It's hard to do and context is crucial.
Take Monday's candle as an example here 👇
"Shooting star, couldn't break out above the range highs, oooh I'd better sell it"
Tuesday rolls in like...
That trade was never on. Give us a sharp move into 170 and maybe things will get interesting.
Summing up, fading the trend is a tough game to play. It can be a profitable game, but just by the very nature of the beast (trends take time to form), you can't play it every day and expect to make money...